The working capital adjustment is one of the most common sources of post-LOI surprises in home care transactions. Sellers agree to a headline price, get into due diligence and purchase agreement negotiation, and then discover that the “working capital peg” mechanism may reduce their actual proceeds by $200,000 to $1 million — sometimes more.
This is not a buyer tactic. It is a legitimate part of M&A deal structure. But sellers who don’t understand how it works — and who don’t negotiate its terms carefully — consistently leave money on the table or receive less than they expected at closing.
In M&A, working capital is defined as current assets minus current liabilities at a specific moment in time (typically at close).
The core concept is simple: every operating business needs a certain amount of “fuel in the tank” — cash, accounts receivable being collected, and other liquid assets — to function normally. When a buyer acquires that business, they expect to receive it with the normal amount of fuel included.
The working capital peg (also called the target) is the agreed-upon level of working capital that the seller must deliver at close. If working capital at close is above the peg, the purchase price increases dollar-for-dollar. If it is below the peg, the purchase price decreases.
Home care agency working capital is more complex than most industries because of:
Accounts receivable: Home care agencies have large A/R balances because Medicare, Medicaid, and commercial insurance payers typically pay 30–90 days after services are rendered. But not all A/R is worth face value. Old receivables (90+ days) are frequently uncollectible. A/R reserves must be estimated correctly, and both parties need to agree on which receivables count toward working capital.
Unbilled revenue: Home care agencies often have services rendered but not yet billed — because documentation is incomplete, authorization is pending, or billing has a backlog. This “unbilled” balance may or may not count toward working capital depending on how the purchase agreement defines it.
Payroll accruals: Home care payroll is processed weekly or bi-weekly. At any closing date, there will be wages earned but not yet paid. These are current liabilities that reduce working capital. Buyers expect these to be included.
PTO accruals: Accrued paid time off is a liability on your balance sheet. Depending on your state’s law and your PTO policy, you may have meaningful PTO accrual that reduces working capital at close.
Medicare cost report settlements: For Medicare-certified home health and hospice agencies, open Medicare cost reports represent contingent liabilities that must be addressed in the deal structure. These are typically excluded from working capital and handled via indemnification.
Deferred revenue: If you received a Medicaid advance or capitated payment for services not yet rendered, this is a current liability that reduces working capital.
The peg is typically set as the average monthly working capital over the trailing 12 months — excluding cash (which typically stays with the seller unless specifically included). The logic is that the average represents “normal” operating working capital.
However:
Negotiations about the peg methodology, the reference period, and the close date can have significant dollar impact.
Because working capital cannot be precisely calculated until close — A/R continues to be collected, payroll continues to be processed — most deals use a post-close true-up mechanism:
The true-up can create post-close payments in either direction. The amount can be substantial — we have seen true-up payments of $300,000–$700,000 in both directions on commercial home care transactions.
Specify exactly:
Open Medicare cost reports should be explicitly excluded from working capital and placed in a separate indemnification framework with a defined liability estimate and reserve.
Whether accrued PTO is included as a working capital liability (reducing the peg, and therefore reducing your exposure to shortfall scenarios) is negotiable. Get explicit agreement in the LOI.
Most deals exclude cash from working capital (seller keeps operating cash). The agreement should specify exactly what counts as “cash” vs. restricted cash vs. deposits.
Negotiate for a reference period that represents normal working capital — not a period distorted by rapid growth, one-time events, or seasonal anomalies.
Many deals include a “collar” — a range within which working capital can vary before any true-up payment is required. For example, the first $150,000 in shortfall or surplus may be ignored, with true-up only applying to amounts outside the collar. This reduces the significance of minor variations.
If the buyer’s and seller’s post-close working capital calculations differ, the dispute goes to an agreed-upon independent accounting firm. Specify:
The most frequent sources of dispute:
A/R collection performance after close: If receivables the seller counted as valuable are not collected by the buyer, the buyer argues they should have been reserved. The seller argues they were collectible. This dispute is very common in Medicaid-heavy agencies where payment delays can extend 90–120 days.
Pre-close billing accuracy: If the seller had unbilled services that were included as working capital value but turn out to be uncollectible after close (due to documentation issues), the buyer seeks a working capital adjustment.
Undisclosed liabilities: If liabilities not included in the seller’s working capital calculation surface post-close — deferred payroll taxes, unrecorded vendor invoices, accrued vacation above what was represented — these create true-up claims.
Accounting methodology changes: Post-close, the buyer may use a different accounting platform or methodology, classifying items differently than the seller did. Well-drafted agreements should specify that the close-date working capital is calculated using the seller’s historical accounting policies — not the buyer’s platform’s default methods.
1. Have your CPA calculate working capital before the LOI. Understand your own working capital position before a buyer proposes a peg. Sellers who don’t know their number are at a significant negotiating disadvantage.
2. Monitor working capital in the period leading up to close. Don’t let receivables age out or payables build up in the 90 days before close. Unusual working capital movements create true-up exposure.
3. Agree on A/R reserve methodology explicitly. Don’t leave A/R reserve calculation vague in the purchase agreement. A difference of 10% in the reserve rate on $2M of A/R is $200,000.
4. Understand the close date’s seasonal implications. If your business naturally has low working capital in January and high working capital in October, closing in January requires a careful look at whether the peg appropriately reflects close-date seasonality.
5. Use an experienced M&A attorney. Working capital mechanics are technical and require specialized drafting. General business attorneys miss these nuances regularly.
Contact Hendon Partners to discuss your home care transaction structure →
Hendon Partners specializes in home care M&A advisory. We have navigated complex working capital negotiations on dozens of transactions.
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